Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: The Trump administration has said a number of times that it was fair to use the stock market’s performance as a scorecard of its success. If that’s the case, how successful has the administration been to date?
Stovall: Well, I would say that the stock market has given President Trump an “A” for anticipation, mainly because he really hasn’t accomplished all that much but the market is still enthused by the prospects of a reduction in taxes, going from as high as 39% to as little as 15%, and to a 10% tax on repatriated earnings. Then, who knows what else will happen in terms of infrastructure spending, etcetera, that could end up driving a 4%-plus growth in GDP. While the President has received nothing but pushback from Congress, investors still think there is reason to be optimistic.
EQ: President Trump did say in a recent AP interview, ‘You live by the sword, you die by the sword’. Considering that every Republican president has seen a recession during their first term in office, could history potentially work against the Trump administration from this perspective?
Stovall: Absolutely. We have gone more than 94 months into this economic expansion, which is more than twice as long as the average expansion since 1900. So, not only is the stock market long in the tooth, but so is the economic expansion. Four years is a pretty long time—meaning his first term—so I think there is a definite possibility that a recession starts some time in his first four years. What I don’t really know is whether it will start in the first two years of his first term, as was the case for every Republican president since 1901, with the exception of Warren G. Harding.
But I also do not believe that a recession is likely to happen in the next six to 12 months, based on economic indicators that I look at. So, for a recession in his first term, I would say there is a very good likelihood. But in his first two years—meaning in the next six to 12 months—I don’t think so.
EQ: As you noted in this week’s Sector Watch report, much of the performance thus far is largely attributed to anticipation of Trump’s policies. We’re past the first 100 days mark now, but what would the best case for the market and the Trump trade look like?
Stovall: The best case would be that you have something akin to what followed the first 100 days under George Herbert Walker Bush, or “Bush 41”. In 1989, that May through October period saw the market up close to 10%. Yet, in every other Republican’s first term in office, the market fell in that May through October period by an average of 4%. So, history would basically say that chances are we’re likely to stumble in the coming six-month period. Therefore, the best-case scenario would be that we do not stumble and, possibly because of the passage of some sort of tax reform legislation, that “sell in May” gets turned into “swell in May”.
EQ: Given that the market has run up on anticipation, how much of Trump’s potential policies are already priced in? How much upside surprise is there left?
Stovall: First off, earnings estimates for all of 2017 have remained stubbornly above the 10% level. Historically, the beginning-of-year estimate has been higher than the end-of-year actual by about 5.5 percentage points. That would imply that we would’ve ended up with a number closer to about 5%, rather than the 10%-plus that was originally estimated. That certainly is what happened in 2015 and 2016, where the earnings estimates exhibited the glide path of a crowbar, going from 7-8% in the beginning of the year, down to 0% by the time fourth-quarter earnings were beginning to be announced.
So, we’re definitely marching to a different beat this time around. I think that part of the anticipation is being built into earnings, but it’s hard to build too much into earnings estimates because we really don’t have much detail on what the President’s tax program is likely to do, and how successful it’s going to be. So, I think basically that something is being priced in, but not too much. Now, if the Trump package does not materialize at all, well then, yes, I think we fall into a pullback of between 5% and 10%, because by my analysis, the stock market is overvalued by about 7% currently.
EQ: It’s safe to say that investor patience is starting to get tested now, and you noted that perhaps the worst-case scenario would be if campaign promises fail to materialize. Is there a risk that patience will run thin sooner than later?
Stovall: Yes, the President is pushing forward his health care plan once again, and it doesn’t seem as if there are enough votes yet to pass it. If he should fail a second time on the health care package, add that to the buzz going around Washington that he caved in to the Democrats in order to avoid a government shutdown, then I think that most people will start to say, “Well, you know what, maybe he’s not as a great a negotiator as he tells us he is,” and therefore, there is probably going to be an incentive for the Democrats to push back on the tax reform package. That could raise concerns that we probably don’t have it approved before Congress goes away on their August recess, and then the question becomes whether they will pass it at all. So, I think there is a definite possibility that this hype is turning to gripe.
